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A Nobel rebuke to Obama’s economic policies

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The conservative argument against President Obama’s policies got a boost from an unexpected place Monday: the Nobel Prize committee.

Thomas Sargent, who with Christopher Sims won this year’s Nobel Prize for economics, was rewarded for a body of work that demonstrates the folly of Obamanomics. While it’s not always easy to translate the words of Nobel-winning economists into terms that into the political debates of the day, Sargent spoke plainly enough in an interview last year with Art Rolnick of the Federal Reserve Bank of Minneapolis. (H/T: Ira Stoll at Reason’s Hit and Run blog.)

On taxes (from the interviewer’s summary of Sargent’s “rational expectations” work):

[P]olicymakers can’t manipulate the economy by systematically “tricking” people with policy surprises. Central banks, for example, can’t permanently lower unemployment by easing monetary policy…because people will (rationally) anticipate higher future inflation and will (strategically) insist on higher wages for their labor and higher interest rates for their capital.

“Tricking” is a good way to describe the desired effect of Obama’s policies: The idea behind his original “Making Work Pay” tax cut was that it would be so small that workers wouldn’t even notice the extra cash in their paychecks, and therefore wouldn’t be tempted to save it rather than spend it.

Along with Milton Friedman’s permanent income hypothesis, Sargent’s theory helps us understand why all tax cuts are not created equal: A temporary payroll tax cut provides little incentive for employers to hire, or for workers to spend more, when longer-term tax increases loom over the horizon. That’s why it’s absurd for Obama to talk about using such tax cuts to stimulate the economy, then talk about raising taxes a year or two from now, and then act surprised that job growth has been slow.

On the 2009 stimulus itself:

The calculations that I have seen supporting the stimulus package are back-of-the-envelope ones that ignore what we have learned in the last 60 years of macroeconomic research.

Ouch.

But the most important thing Sargent might have said in the interview, given that long-term joblessness is arguably the biggest long-term economic problem America faces, had to do with social safety nets, particularly for unemployment benefits:

[W]hen people now become unemployed, they’re taking a more or less permanent hit to their level of human capital…. We have a theory that people build up human capital while they’re working on a job, but lose human capital when they’re displaced from a job. … Unemployment compensation systems typically award you compensation that’s linked to your earnings on your last job; those past earnings reflect your past human capital, not your current opportunities or current human capital. That can make collecting unemployment compensation at rates reflecting your past (and now obsolete) human capital more desirable than accepting a job whose earnings reflect a return on your current depreciated level of human capital. …

The prospect that concerns me might sound like I’m hardhearted, but that’s just the opposite of my feelings. What you’ve seen in the recent recession — and it’s quite natural because it’s been so severe — is a tendency of Congress to expand unemployment benefits, over and over again. What [our] theory tells us is that if, in the United States, we create a system where unemployment and disability benefits are permanently extended in their generosity and their duration, we will inadvertently put ourselves into the situation that much of Europe has suffered for three decades.

These extensions might be done, Sargent says, “out of the best of motives,” but they are still likely to have a perverse result. Now, not all of the long-term unemployed are refusing jobs available to them. But to the degree unemployment benefits encourage someone to stay out of work a little longer than necessary, hoping a better opportunity will come along, they are doing that person a disservice in the long run.

What’s more, they are delaying our coming to grips with the fact that the world has changed in ways that mean we won’t just pick back up where we left off. Sargent argues that the erosion of a worker’s skills has become worse during the last 30 years because of “various technological changes going under the umbrella name of ‘globalization.’ ” Like Obama’s stimulus spending, the continual extensions of unemployment benefits require an assumption that better times are on the way, and all that is needed is a government-provided bridge to close the gap between now and then.

If that assumption is wrong, however, and more structural economic changes are needed, government spending and benefits are not going to bridge that gap. They just might widen it.

– By Kyle Wingfield

Original Article

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